Three Reasons Why Romney's Tax Plan Makes Mathematical Sense

Recall the now infamous Tax Policy Center study that guesstimated
Mitt Romney’s tax plan would a) cut taxes for high-income
earners by $86 billion in 2015 and thus b) require an $86 billion
tax increase on the middle class so as to not increase the
deficit.

1. More base-broadeners are on the
table. TPC originally claimed that the Romney
plan would raise taxes on the middle class by $86 billion.
After a critique by AEI colleague Matt
Jensen, who pointed out additional opportunities for
base-broadening, TPC downgraded its estimate considerably.

Specifically, Jensen pointed out that the exclusion of interest
on state and local bonds and the exclusion of inside buildup on
life-insurance products could yield more revenue. TPC then
acknowledged that repeal of these provisions would raise
approximately $45 billion from high-income taxpayers, reducing
any need to tax the middle class by the same amount.
The result: A
purported $86 billion tax increase on the middle class shrinks
to $41 billion.

2. The TPC revenue baseline assumption is
inflated. TPC assumed that the baseline against
which Romney is seeking revenue neutrality includes a 0.9
percent surcharge on “earned” income and an additional 3.8
percent surcharge on “unearned” income of high-income taxpayers
that were adopted in the healthcare law. Romney has proposed
repealing these taxes, but has not suggested that the cost of
repeal would be paid for by tax reform. Instead, the budget
effect of repealing these taxes should be analyzed in the
context of the repeal of various other healthcare provisions.

Despite TPC’s assertion that adjusting its baseline assumption
“does not alter our primary conclusion,” the revenue
consequence of repealing this tax in 2015 is a full $29
billion, all of which falls on high-income earners. Correcting
the baseline by removing this provision means that more of the
revenue raised by broadening the tax base on high-income
taxpayers can be used to finance tax reductions for the middle
class. The
result: A $41 billion tax increase shrinks to $12
billion.

3. Even modest economic growth makes a
difference. TPC also misconstrues analysis on the
relationship between tax reform and economic growth. Not only
does the TPC model assume zero economic growth, but the
Center’s analysis (subsequently echoed by many other
commentators) points to research I published with AEI colleague Alan
Viard to argue that economic growth is not possible
from revenue-neutral income tax reform. This conclusion is a
false interpretation of our research.

An increase in labor supply is one means by which an economy
can grow; as Viard and I pointed out, revenue-neutral tax
reform is indeed unlikely to yield gains on that front. But tax
reform can also grow the economy by encouraging capital
formation and promoting the proper allocation of capital across
the economy. Romney’s plan will do just that.

Based on Table 3-1 of the “Analytical
Perspectives” report by the president’s Office of
Management and Budget, I compute that if the economy were to
grow just 0.1 percentage point faster per year as a result of
the reform, the additional revenue in 2015 would be
approximately $13 billion. The result: A $12 billion tax
increase on the middle class actually becomes a tax cut.

And just like that, the Democrats’ attacks that Romney wants to
raise taxes on the middle class become false.